KB Home (KBH) 2002 Q4 法說會逐字稿

Good day, everyone, and welcome to the KB Home year-end earnings conference call.

As a reminder, today's call is being recorded.

KB Home's discussion today will include certain projections and forward-looking statements in order to help investors better understand KB Home's business products -- I'm sorry, prospects. These are based on their assessment of current business and operating conditions. Please be aware that actual results may differ from those that may be expressed or implied by the projections and forward-looking statements, and the differences may be material. These discussions in the company's annual report on Form 10-K, quarterly reports on Form 10-Q, and the current reports on Form 8-K filed with the SEC identify various factors that could cause actual results to differ from those that KB Home will be projecting in the forward-looking statements that will be made today, and we urge you to read those.

I would like to remind everyone that this teleconference is being Webcast on KB Home's Web site at http://www.kbhome.com.

For opening remarks and introductions, I would now like to turn the call over to KB Home's Chairman and Chief Executive Officer, Mr. Bruce Karatz. Please go ahead, sir.

Thank you very much, and good morning to everyone. Thanks for joining us today to discuss our record results for the fourth quarter and full year 2002.

With me this morning are Jeff Mezger, our Executive Vice President and Chief Operating Officer; Dom Cecere, our Senior Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President, Controller; and Clem Tang (ph), Director of Investor Relations.

Our agenda this morning will cover the following topics. First, I will provide some highlights of our financial performance for the quarter and fiscal year just ending, comment on the current state of the business, then I'll turn it over to Dom to review our fourth quarter profitability and other key financial information, and finally I'll wrap it up with our business and market outlook for 2003. And at the conclusion, of course, I'd be happy to address any questions you may have.

I'm very pleased with our strong fourth quarter results, which contributed to KB Home achieving its fifth consecutive year of record earnings. Our company-wide emphasis on systems and processes to improve the quality of our business at all levels of the enterprise continues to deliver tangible and quantifiable results.

Our financial scorecard speaks for itself. We closed the November 30, 2002 fiscal year with an ending backlog of approximately $2.35 billion, up 23 percent over 2001, giving us good visibility for forecasting our sales and profitability for the first half of this year. Total revenues for the quarter reached 1.68 billion, up 16 percent from the year earlier quarter. For the year, total revenues exceeded 5 billion, an increase of 10 percent over the prior year.

The company's net income for the fourth quarter increased 40 percent to a record 124 million on top-line revenue growth of 16 percent. Net income for the year rose 47 percent to a new all-time high of $314 million from $214 million a year before. Our diluted EPS rose 44 percent to $2.92 per share for the fourth quarter '02 from $2.03 a year earlier, extending our record to 30 consecutive quarters of meeting or beating consensus estimates.

For the year, we generated $7.15 in diluted EPS, up 30 percent from 5.50 the year before. In 2002, we repurchased 4 million shares of our stock at an aggregate price of $191 million. We currently have an outstanding authorization to repurchase an additional 2 million shares. We continue to believe our stock is significantly undervalued, and stock repurchases are still an excellent use of our strong operating free cash flow.

Finally, our after-tax return on invested capital was approximately 17 percent in '02, almost triple the average for the S&P 500. Our razor focus on maximizing company-wide returns is delivering substantial free cash flow. In 2002, we utilized our free cash flow to organically expand our community counts for this year by over 20 percent to acquire American Heritage Homes and the assets of New World Homes, and to repurchase 4 million shares of our undervalued common stock. Also, we ended the year with approximately 330 million in cash and no borrowings under our outstanding $644 million revolver.

Now let me comment on our business accomplishments during the year. We delivered 25,565 homes. Our focus on geographic markets with above-average population and employment growth and the segment of buyers where the largest growth is in new household formations is projected to give us the best opportunity in the industry for continued increased profitability.

We continue to invest in organic growth to expand market share in our served markets. In these markets, our KB Next operating model continues to provide clear operating advantages, especially against over 70,000 private builders who continue to have a significant, albeit eroding, share of the still-fragmented U.S. market.

While a lack of active selling communities tempered our unit growth in 2002, we turned the corner in the fourth quarter and are well positioned for 2003. In the fourth quarter of '02, our overall average number of active communities increased approximately 2 percent to 386 from the same quarter of '01. In the U.S. alone, our community count rose more than 5 percent to 288 in the fourth quarter of the year. We have an aggressive schedule to open over 100 new communities in the U.S. over the next several months, setting the foundation for revenue growth for 2003 and beyond.

In addition to our organic growth, we continue to pursue acquisition opportunities. In 2002, we acquired American Heritage Homes, a Tampa and Orlando home builder that delivered over 800 homes in 2001 and currently controls in excess of 4,000 lots. This acquisition strengthened our foothold in Florida, supplementing our Jacksonville operations and our Tampa startup business. We fully expect the Florida market, where over 90,000 homes are built annually, to provide a new geographic platform for growth for the company.

During the fourth quarter, we also acquired the assets of New World Homes, the fifth-largest builder in Tucson, further strengthening KB's number one market position in this region. This acquisition included 1,600 lots and 12 new home communities located throughout Tucson.

Responding to the brisk pace of growth in Texas, Rio Grand Valley, we opened a new Texas valley division to serve first-time and first-move-up buyers in the region. We're particularly excited about the growth prospects in this area as the 2000 U.S. census showed MacAllen Edinburgh Mission (ph) as the fourth fastest-growing metropolitan statistical area in our country.

Our asset management activities during the quarter included the transfer of partial ownership of a large land holding in Palmdale, California that we've owned for many years. The transfer was made in connection with the formation of a partnership to develop the approximately 5,000 lot parcel. While the development will be managed by a third party, KB will maintain a significant ownership interest in the property, and intends to build homes on a number of the developed lots. This new venture significantly reduces our investment in this particular submarket, while still providing a lot pipeline well into the future. The transfer had no impact on our earnings for the fourth quarter, as no gain or loss was recognized in connection with the transaction.

In addition to laying the groundwork in 2002 for future growth and expansion, we continued our focus on providing quality service to our customers and building the best homes in the industry. Our focus on the customer drove our customer satisfaction index in 2002 to a record high of 95 percent.

As part of our overall focus on the quality of our homes, we improved significantly on warranty claims. Overall, the number of warranty claims was reduced by 45 percent. The average time to close a warranty claim was reduced from 13 days in '01 to just five days last year. And the number of warranty claims outstanding over 17 days was reduced from 287 in '01 to only 26 last year.

One of the things I'm most proud of in 2002 is the strong financial performance of our core home building business. Combined profits from land and commercial activities for the year were very small, and our mortgage banking results, while strong, were less than 10 percent of the approximately $600 million in EBITDA the company generated in 2002.

We had a great year in 2002, and I'm proud of our entire KB Home team, their commitment to our business, and the measurable results that they continue to deliver on behalf of our company.

Now I'd like to ask Dom to take you through some of the financial highlights of the fourth quarter.

Thank you, Bruce. If you would, please turn to our exhibit labeled "Consolidated Statements of Income."

The company's construction revenues for the quarter reached 1.66 billion, up 16 percent from the same quarter of 2001. We delivered 7,932 units in the fourth quarter, about even with the 2001 deliveries. Our construction revenue for the quarter was driven primarily by a 13 percent increase in the average selling price. Our construction pretax income for the quarter rose nearly 40 percent to 167 million. As a percentage of revenues, construction pretax profits of 10.1 percent rose 170 basis points from 8.4 percent in the fourth quarter of 2001.

During the fourth quarter, we increased our housing gross margin by 180 basis points to 22.6 percent from 20.8 percent for the year-earlier quarter. Our SG&A ratio in the fourth quarter rose slightly on housing revenues to 11.6 percent in 2002 from 11.4 percent in 2001. The increase in SG&A cost came as a result of higher incentive compensation tied directly to the improvement in fourth quarter pretax income.

Our mortgage banking pretax income of 18 million was up 23 percent in the fourth quarter of 2002 from 15 million in the same quarter of 2001. Growth in our mortgage banking results continues to be driven by the increase in our retention rate and average loan size, as well as continued favorable interest rate spread.

Our company-wide pretax income of 185 million for the fourth quarter was up 38 percent from the same quarter of 2001, and our pretax income jumped 180 basis points to 11 percent. The company's effective income tax rate for the quarter remained at 33 percent, a one percentage point improvement from the year-earlier period.

Net income increased 40 percent to a record 124 million in the fourth quarter, up from 89 million in the same quarter of 2001. Q4 EPS of $2.92 increased 44 percent from the earlier quarter EPS of $2.03, also benefiting from 3 percent fewer average diluted shares outstanding.

For the year 2002, total revenues of 5.03 billion increased 10 percent from the full year 2001. This reflected a 3 percent increase in deliveries to 25,565 units, and a 7 percent increase in the average selling price. Net income for 2002 of 314 million was up 47 percent over 2001, and our EPS of $7.15 was up $1.65, or 30 percent.

In summary, our profitability for the quarter and the year was again excellent, with strong operational performance based on our KB Next operating model driving substantial earnings growth. This was achieved even while we invested in land and land development and entered new geographic markets to expand our footprint for profitable growth.

Turning to our balance sheet, we will now review the change in investment deployed in our business. The company closed 2002 with approximately 330 million in cash versus approximately 281 million at the end of 2001. In 2002 we generated strong free cash flow, allowing the company to use approximately 191 million to repurchase 4 million shares of our KB (inaudible) stock. We also made net investments in inventory of 289 million since last year to expand the number of active communities from which we will be selling homes in fiscal 2003 by over 20 percent.

We currently have over 110,000 lots in inventory compared to 86,300 lots this time last year. Approximately 50 percent of our lots are now under option contract. We continue to focus on maximizing the number of available lots to grow our business, while at the same time minimizing the initial upfront outlay of cash required for land. Our rigorous land approval process continues to mitigate our financial risk, and permits our operating divisions to invest only in communities where the return is significantly above our cost of capital.

Our return on invested capital for 2002 was approximately 17 percent, up over 200 basis points from the prior year and almost triple that of the S&P 500. Our balance sheet remains solid at the end of 2002, and reflects substantial financial flexibility. The company's leveraged ratio improved 210 basis points to 47.8 percent compared to 49.9 percent in 2001, and when including construction cash as a reduction of debt, the ratio improves to 40.2 percent.

Our construction debt totaled just under 1.2 billion at November 30th, 2002 and had an annual interest cost of approximately 100 million. When our interest costs are compared to 2002 EBITDA of 596 million, it gives us a solid interest coverage ratio of 5.9 times our cost of debt, an improvement of nearly 37 percent over 2001.

Now, if you would please turn to our exhibit of supplemental information. Company-wide, our average selling price for the fourth quarter was $202,000, up 13 percent from 178,800 a year ago. During the fourth quarter, the overall average selling price for the U.S. operations rose 12 percent on a year-over-year basis. The continued shortage of housing in California drove prices in the West Coast region up 18 percent, while the southwest and central regions prices rose a modest 3 percent to 4 percent. In France, the average selling price in U.S. dollars rose 18 percent on a year over year basis. Foreign currency effects accounted for about 10 percent of this increase.

Finally, we ended the year with a healthy backlog of 12,023 units with a dollar value of approximately 2.35 billion, the highest UN (ph) backlog in our history. In our West Coast region, where a long-term shortage of housing exists, we continue to experience strong unit demand in pricing. In California, the dollar value of our backlog at November 30th, 2002 was up more than 66 percent from November 30th, 2001.

Entering 2003, our dollar value in backlog was up 23 percent, improving our visibility for the first half of the year and limiting any market risk we might have in achieving our 2003 objectives.

Now I will turn it back to Bruce for the wrap-up of the fourth quarter conference call.

Thanks, Dom. While there continues to be an abundant amount of sensationalism in the media about the housing sector, the sector continues to outperform the market as a whole. It sailed through both an economic and market turndown seemingly untouched, while people love to speculate on how long public builders can defy history and deliver exceptional results quarter after quarter. And for that reason, builder PE multiples are at historic lows.

My own view is that big builders operate more professionally, with less sensitivity to the interest rate environment, and with better access to capital, which accentuates our advantages, among other reasons, over small and medium-sized builders. We at KB Home continue to believe in the fundamentals of the home building sector. The long-term favorable outlook for the home building sector is not wishful thinking, but is fact-based, which is convincingly positive.

Mortgage rates are at historical lows, driven by an economic environment of low inflation and slow economic growth. This, coupled with a firmer job market, unabated population growth, and immigration will drive new home sales for the foreseeable future.

We continue to believe that our financial track record, powerful cash flow generation, seasoned management team, and world class operating model will eventually get rewarded in the markets for our continued above-market financial performance.

Based on current PE multiples, home building stocks are trading at 6 to 7 times 2002 earnings, while the S&P 500 trades at over 20 times. From a risk-reward perspective, we believe there's no better place for an investor to put their money than in the home building sector, and as far as we are concerned, no better company than KB Home.

In fact, for the calendar year 2002, KB Home stock achieved an 8 percent return versus a loss of 22 percent for the S&P 500 index. And over the past three years, KB Home has returned an average of 22 percent per year to our shareholders compared to a 14 percent loss per year for the S&P 500 index.

The other day, I was looking at our company's results at the time that we spun off from Sun America in 1986. Our revenues at that time were under $400 million, and our stockholder equity was less than 100 million. In the 17 years since that spin-off, our revenues have grown more than twelve-fold to $5 billion, a compound annual growth rate of 17 percent, and today's net income that we reported of $314 million for the year also grew at a compound annual growth rate of about 17 percent through good years and bad.

This didn't happen by accident. We established operating systems and processes and invested in our people. We allowed our businesses to maintain their entrepreneurial spirit in addressing local market needs while operating uniformly and consistently in a financially disciplined manner. I firmly believe that our KB Next operating model will allow us to continue to grow both the top and bottom lines and become one of the premier companies in America.

Now let me turn to the outlook for KB Home for 2003. We are maintaining a strong market position in all of our existing markets and will continue to expand in the new markets that fit our overall strategy for profitable growth. Our balance sheet should continue to strengthen in 2003 with strong operating earnings flowing through to stockholder's equity and key borrowing ratios improving. The current bond market is extremely favorable for public builders because of their strong earnings and consistent track record of financial performance. KB Home plans to access the Capital Markets shortly with a public debt offering of at least $200 million to reduce our average cost of debt and to lengthen the term of our portfolio. The proceeds from this offering will be used to prepay existing debt and for general corporate purposes to facilitate future growth.

Based on the current economic outlook, we are targeting our business to deliver double-digit revenue and earnings growth in 2003. Revenues are expected to be approximately $5.5 billion, and our earnings per share is forecasted to grow to approximately $8, up 12 percent from the 17 -- $7.15 posted this past year. We will continue to focus on above-average returns on invested capital to drive strong free cash flow.

Our operating cash flow will continue to be used to invest in organic growth, to acquire builders where the markets and financial evaluations make economic sense for our business, and to buy back shares of our undervalued stock.

With that, that concludes our formal remarks, and I'd now like to open up and take your questions.

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key, followed by the digit one on your touch-tone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order that you signal us, and we'll take as many questions as time permits. Once again, please press star one if you do have a question.

And our first question comes from Ivy Zelman of Credit Suisse First Boston.

Good morning, everybody. Congratulations on a great year. Very impressive, and really the focus on return on capital, I think, is terrific.

Thanks.

Bruce, can you just give us sort of market color, go through a little bit of the regions? You know, obviously California continues to be great. Tell us what's happening in Texas, because that's been an area of concern, and what you're seeing in more of the other markets, just from a demand perspective, because we have been hearing a lot more competitive landscape out there in certain markets.

Well, you've, I think - you summarized a good part of them. California remains strong. It varies depending upon the part of the state. But on the whole, California stays very strong. Nevada stays very strong. You know, there's been a lot of speculation ever since 9/11 in the tourism issues, but the housing market in Las Vegas remains very strong. Likewise in Arizona.

When you get to Texas, Texas, we sold slightly fewer homes in 2002 than we did in 2001, although we had record deliveries and record profits. And as we look into this year, we think, although it's a mixed bag since we now build all over Texas, you cannot simply generalize about the whole state, but there probably will be some continued softness in some Texas markets into '03.

Having said that, we believe, in the price ranges we're operating in, and with the competitive advantages that we believe we have over many, many competitors there, that we will match or beat what we did in '02 in this coming year in Texas. Colorado, also some softness, but having said that, we believe we can compete very nicely in '03 and expect also to be able to meet or beat what we did in '02.

And then, as you go further east, you know, these are new markets for us, so from our standpoint, it's all looking good right now. We don't have a huge business there yet to comp. The one factor that an investor should take into consideration when thinking about us and our business in '03, we will be operating with significantly more communities in '03 than we did in '02. So even if the market -- markets do soften, we think that our community count ought to mitigate a lot of that.

OK. And then Bruce, with respect to one of the statements you made when you were in New York at the hotel -- the St. Regis, you had said that you were going to continue to report monthly new orders, you weren't going to stop, and yet you decided to stop. Can you give us some indication of what changed your view? And some people have been - bears (ph) are reading into -- that December was not good, and that's why you stopped doing it. Can you give us your thoughts on that?

Sure. One, we were the last of the big public builders to report monthly orders, and frankly, there were very few people out there who clapped their hands with our decision to continue disclosure. On balance, we concluded that releasing monthly orders, which can be very volatile from month to month, that the data can be easily misinterpreted or overemphasized, and that we concluded that the most accurate indication -- one, unlike the retail business, we do not have same-store sales. As much as we all would like to think it is, each community is unique.

But in any event, having said that, we think that the most accurate indication of our health of the business would be quarterly results, fully financial -- full financial information, including sales rates. And I will tell you that we've delivered 30 consecutive quarters of meeting or beating estimates, and we don't see any reason why that's going to stop anytime soon.

All right. Thanks, Bruce.

And we'll take our next question from Joseph Sroka of Merrill Lynch.

Good morning, everyone. Congratulations on a nice full quarter and year.

Bruce, maybe I missed this, or I'm just trying to triangulate it. 386 communities at the end of the fourth quarter. The comment, open 100 over the next several months. Can you just sort of give us a flavor or a sense where you think you end '03, and then, are the openings front-weighted or back-weighted?

Let's see if -- what we can get you here.

Both total and U.S. if you can give it to us separate.

All right. Well, we forecast ending the year at around -- and Bill, correct me if I'm wrong, but I think we're at, like, about 400 in the U.S., and about 500 when you include France. So the number increases as we go through the year.

OK. And is there an emphasis in any particular region?

You know, it's smooth, obviously, on a percentage basis. The East, you know, has bigger percentage because we're coming off of very, very low comps. It's pretty even across it. I mean, on a percentage basis of communities, it might be a little less in the West than in the Central and Southwest, but it's across the board.

OK. I think where a lot of folks take aim at you guys is questioning whether some of your home buyers are financially sufficient to afford the homes. Can you kind of walk us through your mortgage operation and sort of hit what your capture rate was, what you think your average loan to value ratio is across the company, and about what the mix of fixed to adjustables was.

Well, our capture rate was about 90 percent, which was among, I think, the highest in the industry. You know, we do not keep any of the loans that we originate, so the risk of foreclosure is nonexistent within our mortgage operation. The issue that you touch on, Joe, is one that, yes, a significant part of our business is to first-time home buyers, and we're very proud of that, and the U.S. government, through HUD, with the full support of our president, has permitted a Down Payment Assistance Programs that are referred to as DAPs (ph), and these programs were there trying to strike a balance between improving prospects for home ownership, as well as potential expanded credit risks for HUD.

And as we reporting, I think, in the beginning of December in response to this article that came out, approximately 13 percent of our deliveries were these down payment-assisted loans. The business was primarily in Texas and Colorado, and that the dollar value represented about 10 percent of our total revenues. We continue to strictly follow FHA guidelines in qualifying all potential home buyers, whether they use a Down Payment Assistance Program or not. Buyers under these programs still have to qualify for FHA loans under the same guidelines as those who are putting up their down payments.

And looking forward, you know, it's hard to predict the number of buyers that will use these programs. They are promoted by non-profits, but my guess is that we will not see -- will not see a significant increase in the total percentage of deliveries in '03 at our company using these Down Payment Assistance Programs.

OK. And then, just -- part of the issue with the Down Payment Assistance Programs is the extremely high loan to value ratios, so sort of company-wide or in the 90 percent that you're capturing in your mortgage ops, about what's the loan to value mortgage ratio?

Well, remember, if I understand the import of the question, we're talking about no -- where the home buyer is not putting any down payment down, and so essentially you're looking at a loan which would be somewhere in the, you know, 95 percent to 97 percent range. But again, these loans pass through to Fannie and Freddie or other investors, so it is not a continuing risk for KB Home.

It would only be a risk to you if you're selling against yourself versus a resellment community?

Well, I'm not sure I follow that.

Just -- if you hadn't completed the community and you were to have a default and that home came back on the market.

Oh, and the home came back -- well, here.

I don't want to belabor it, but ...

No, no, no. But let me tell you, I've been in the business long enough, you know, there are times when, in certain communities, and if you -- where there were foreclosures during, you know, I think back in the early '80s and you could go into communities where you'd see three or four or five foreclosures, and it wasn't pretty. I will tell you, all those communities ended up being built out. Someone ends up living in the home. The sign ends up being taken off of the front yard, and people go on, you know, with their lives. So there's really nothing much new with those circumstances.

In the present environment, that's the furthest from our concern, since we're seeing continued pricing upward pressure. So, you know, usually the only time you get foreclosures is when the asset is perceived to be worth less than what people paid.

OK. And then last question, I'll pass it. Are you doing full mortgage operations in all these Florida markets that you've gone into in the last year or two?

Yes. We're right now integrating all of the business of American Heritage into our mortgage operation.

Excellent. Thank you for answering the questions, Bruce.

Yeah, thanks, Joe.

And moving on, we'll take our next question from Carl Reichardt of Banc of America Securities.

Hi, guys. Wanted to follow-up on that warranty issue that you mentioned. My understanding is that you're booking a contingency in every home sale for warranty. About what is that amount, and do you expect that the fall in '03 and what would be the attendant impact on margins, if I'm thinking about it right?

You know, Carl, I don't think we disclose what our outstanding warranty reserve is. I can tell you it's adequate, and it is something that we look at all the time. I don't think we would predict that it would be less, although that's something that is difficult to, you know, predict at the beginning of the year. But it is something that we continue to watch, and we want to be sure that we've got adequate coverage for, you know, almost anything imaginable to come down the pike.

OK. But if you were able to work it down, and you determine that, ultimately, going forward, doing a better job here, we might want to reduce it a little bit, the benefit is going to show up in gross margins, correct, if you made that decision?

That would be the effect, yeah.

Finally, Bruce, we haven't talked in a while about acquisitions and new markets for you guys. Could you just kind of give me a rundown of the two or three markets that look maybe particularly interesting to you, and if you found the right builder there, or the right ((inaudible)) opportunity would be a place you guys might think about going?

Yeah, the place obviously that we have several interests. One is, we have a very strong interest to continue expanding our footprint across the South, if you will, of the United States. We want -- while we believe we have great diversity in our present investment portfolio, we'd like it even to be more so, and for people to clearly understand that we are national in scope, and let's not get focused on any single market or what might be happening as determinative of whether to invest in our company.

Secondly, we have existing markets that we are in where we have dominant market positions, where we believe we have significant competitive advantages over all, or almost all, of the competitors there. We would like driving that home and continue to find opportunities to expand our dominant market share. An example is what we just did in Tucson; albeit in a, you know, modest-sized market, we found an opportunity that, while we were the largest, this really makes it even bigger and, we think, more profitable, and again, drives the stake farther, if you will, in those markets.

So, even in places where we have great businesses, if opportunities present themselves, we will take advantage of them to expand those businesses. And one of the things that -- flexibilities that it gives us is, where we have big businesses, and we have opportunities to expand them, we are always continually buying large inventories of land.

So, should things change, you know, an acquisition may not make the business bigger, it may just simply fill a needed land pipeline to maintain the business that we already have. So those are the two areas. Specific cities I'd rather not get into, but you'll be the first to know when something happens.

All right. I'll stop asking questions you can't answer. I have one more, which is, again, we haven't revisited the design centers and what they're contributing. Do you have an idea of what percentage of ASP now is option upgrades and sold out of the design centers?

You know, right - yes. That I can answer. We are running at 8.5 percent now of base sales price in our option business. We continue to believe that number should continue increasing. Margin is also improving, and we continue to love the business, and we're managing it harder and, I think, more creatively, and I think that will continue to help us drive our margins.

And that 8.5 percent is up versus what last year?

Well, the year before -- does anybody -- yeah, my colleagues just told me it was up about a percent from '01.

Great. Terrific. Thanks so much, Bruce.

Yeah.

And Greg Nejmeh of Deutsche Bank has our next question.

Good morning, Bruce and other members.

Couple of questions, Bruce. You expressed frustration with the performance of your equity. You're certainly not alone. I wonder, in view of the administration's proposal regarding dividends, any consideration being given to some alteration in the dividend policy, either on an ongoing basis or as a one-time?

Well, you know, obviously we talk about it. We don't spend a lot of time, because it's still speculation as to whether or not that will be adopted. It's possible, I think -- I don't think we would be among the first to take a significant percentage of our earnings and put it out of dividends. The one-time does seem, you know, like an attractive possibility. I could see -- you know, we do pay a 30-cent dividend now. I think it will have an effect in our industry because the good businesses are driving significant positive cash flow, and at these kind of valuations, if you got, ideally, a tax-free distribution, it would certainly be attractive for people who owned significant blocks of stock.

But frankly, we can't predict what will happen in Washington, so we'll wait and see, and look to see how the market reacts to it. I think our industry is not likely to be among the first to jump into that, though, and we can see what -- how investors (view it all).

You mentioned your return on capital, which is certainly impressive. I wonder, if you were to disaggregate that - and I recognize it may be difficult to do -- but if you were to disaggregate that number and look at it by region or by line of business, is there a high degree of variability between the high and the low businesses or geographies that comprise that 17 percent average?

There isn't, but what there is is -- our French business, curiously, over the last several years, is below our company-wide averages, both margins and return on capital. And remember that we own only 53 percent of it, although we aggregate the entire business. So, you know, one way to look at it, I mean, you know, someone really has to want to get into a great deal of minutia. But if you were to disaggregate France, it would be a very nice positive variance on our return on total capital invested and on our margins.

Within your domestic operations, then, are you suggesting that there is not a high degree of variability?

There's not, no. There's not. You mean, like, between the lower price range and a higher price range and ...

Or, you know -- or California and Texas ...

No. Actually, California, we've done, I think, a nice job -- you know, you go way back with us. But, you know, what, three years ago, I was trying to say that we were reorganizing our California business to get it in line with KB 2000, KB Next, and we've done it. And so the returns now have -- are matching our average returns, and we like the way we're managing it, which is one of the reasons that we went into this transaction in Palmdale, which was a long-term buildout and was from another error, and sold, you know, half of our interest in that.

Just one final question, again, related to the return on capital. When you look at your markets disaggregated in a different manner, that is, those markets that are more highly concentrated, wherein the shares of the large builders tend to be higher versus those markets that tend to be more fragmented today, is there much of a differentiation ...

Excuse me for cutting you off. I know exactly what -- we haven't done a definitive study. I believe -- which I think was the inference that you were leaving -- I believe that big builders operate better in markets that are dominated by big builders, and I think that is one of the -- what I would say underlying trends that is benefiting big builders overall throughout the country, because while big builders represent today, depending upon who you ask, about 20 percent of the new home market in the United States, if you look at the big markets, it's probably closer to 40.

And as those percentages get bigger, I think that there's less nonsense, you know, monkey business that goes on in markets, the pricing is more rational, and I think that benefits the big builders.

But that's more your instinct than any empirical study.

Well, you know, there's nothing that I'd have to share with you. I think that will be a -- I feel that way. It follows our basic premise of KB Next of dominant market share. We know that, in the markets where we have dominant market share, our biggest businesses perform better than our smaller businesses. And for many years, I don't think you were one of them, but people question why you would want to invest so much in a single market. And the fact is, like other industries in home building too, when you have dominant market share, good things happen, and that, we have proven.

So then you go farther and you say -- when you talk to our business leaders, you see less pricing craziness by people having to, you know, burn and run. And I think we all benefit from that.

Terrific. Great quarter. Thanks.

OK.

And our next question comes from Michael Rehaut from JP Morgan.

Hi. Good morning. Great quarter. Couple questions. First, terms of what was going on in California, I was wondering if you could give us a little bit of color on the ASP gain there, if it was driven more by a mix shift to, you know, bigger homes or more expensive communities, or if it was more driven by, you know, pure home price inflation or better lot premiums. And also what's going on in land prices in California in the past year. Have land prices been rising faster than home prices?

Yes, Michael. One, California has benefited by above-normal upward pricing pressure. It's being driven by a shortage of housing, for the most part, in an economy that's OK -- you know, it varies from, obviously, the job weakness in the northern, you know, Bay Area to particular strength in parts of, you know, the inland empire in Southern California.

Land prices do continue to rise. So far, those kinds of increases have not -- have not hurt margins because we've been able to offset it by increases in pricing. Our own view is that these kinds of price increases, which, frankly, over the last three months, were running almost 17 percent, is not something that is sustainable. And so we are looking at ways to build higher density product, which will allow us to amortize a costlier acre of land and yet keep the average price more affordable. And, you know, and so far, that, I think, is working.

All right. And would you say land is rising faster -- land prices are rising faster, or at the same pace versus home prices in California?

You know -- no, I wouldn't -- you know, that's a perennial question. I do not think there is an imbalance yet between -- although we are usually buyers of land, not sellers, so we're continually saying that land is getting too expensive. Nevertheless, our margins are continuing to improve, so I think it's hard to make the case that land is going up too fast.

OK. And just lastly, some balance sheet stats, if you would. If you could just sort of break down the inventories, percentage of that represented by land versus, you know, homes in construction or backlog this year versus last year, and also your year-end lots position, owned and optioned.

Well, we've said in the script our lots addition was 110,000 lots versus 86,000 last year, and that 50 percent of those lots are now under option contract. So for the company, our total inventory for land and construction was up 15 percent in dollar terms, but our lot positions were up 27 percent. So we did a nice job of being able to put more lots on our books at a lower cost to carry those lots.

OK.

And Bill, do you have the inventory?

William R. Hollinger. The inventory a year ago was broken down in terms of -- between homes, lots, improvements in production of 1.4 billion (ph) versus -- and land under development of, basically, about 500 million. And today -- I'm just looking it up here a second. Today the total of 2,173,000,000 (ph) is broken down between home lots and production of 1.8 and 400 million for land under production.

OK. Thanks very much.

OK.

And moving on, we'll take our next question from Juan Espinosa of Wellington Management.

Good morning. I don't know if my question would have an easy answer, and maybe it's too esoterical, but I was wondering if there is any estimation as to what would be the impact of the multiple -- the high number of people who are unemployed in the regions where you operate coming back into the market as the economy improves? I don't know if anybody has done any exercise to reflect that.

No. No. Your question is, as jobs are -- as the job market improves, what does that do for the number of people in the home-buying market?

That's correct.

Yes. You know, we don't. I mean, what we know is that, as the job market improves, most people believe interest rates will rise, and from a home builder perspective, it ought to give us more people who could buy. And if they can't qualify at the higher rate, then we would qualify them with an adjustable rate mortgage. And so we would be wholly in favor of a better job market, even if that meant that rates were to rise, because you do need a job to buy a home, at any rate.

Thank you.

And our next question comes from Chris Bauders of Raymond James.

Hi, great quarter. Just real quickly, you gave a number for EBITDA for FY '02. Can you just give what the fourth quarter EBITDA number was?

We can. Just a minute, Chris -- 220,000,478 (ph).

And then do you have an interest incurred number as well for the quarter?

Yeah. Interest incurred for the quarter, 27,093 (ph).

Thank you very much. I appreciate it.

And moving on, we'll take our next question from Robert Kirkpatrick of Cardinal Capital.

Good morning again. Let me add my congratulations. Can you give us an idea as to what your cash flow was from operations for the year, and then I have a follow-up on a different topic.

463 million.

And that compares with a much lower number last year?

Yeah. It was, like, 45 million.

OK. Bruce, you reported on the tape this morning as mentioning something about mergers with some -- two particular other companies. Would you care to expand upon those comments?

OK. Well, if you were listening to the interview, whomever was the guest on -- with Mark Haines (ph) this morning on Squawk Box asked me if we were -- if I thought we would be acquiring NVR (ph) or Hubnanian (ph). I mean, it came out of the blue.

And my response was that I thought both of those names were high quality home builders, both of whom I would be very happy to be associated with, but that I didn't think that there would be combinations -- big combinations of that order until the valuations were rationalized more -- meaning, you know, when big builders start trading at, you know, 12 to 15 times earnings, I think we will start seeing some big combinations. I do believe consolidation continues. You've seen it. We're going to have a number of very big companies in our sector. But I would -- I don't think those kinds of combinations are going to occur until valuations change.

Great. Thanks so much for expanding on that.

Yeah.

And next we'll go to Margaret Whelan from UBS Warburg.

Good morning, guys. Congratulations on the quarter. And I jumped on a little late, but I missed the cancellation rate, if you provided it.

Margaret, you didn't get on late enough. We didn't. Let's see if we can give that.

For the quarter?

Yeah, you want the quarter?

Yeah.

OK. Just a minute.

Or the year or ...

Well, overall, it was 39.6.

39.6 for the quarter, Bill?

Right.

That was your cancellation rate?

Yes.

How does that compare with the earlier quarter?

Well, that compares to a year ago, it was down slightly, up 41.6.

OK. And I guess one of the things that folks worry about when you stop reporting your monthly numbers is that maybe it's an early warning sign, and the closings were a bit lighter than we were looking at.

Well, I guess the first thing I'd say is, December is the lowest month of the year to begin with, so I don't think anybody ought to get -- you know, ought to get wrapped up on December, all right? And we thought that was an appropriate time do it because it was December, all right?

Having said that, that as we get into the year, January is looking a lot better than December, and we see, as we're looking forward, we have every confidence that the kind of guidance that we have just given is going to be met.

So, having said that, remember the guidance we gave was not -- was sort of 8 percent on a unit growth, 10 percent on revenues, and 12 percent on earnings, so we've -- you know, we have dialed back, and we hope it might be better as the year unfolds, but that's the kind of guidance we're giving right now.

Do you have a cancellation rate for the third quarter?

You know, we don't.

Or the August quarter?

Could you call back -- call Bill?

Sure. And Bruce, just tell us, in your experience, what are the early warning signs you would be looking for, you know, away from that? Is there any kind of slowdown in pricing, incentives, or anything?

You know, that is a good question. For the last two or three years, every time we thought we had signs of a slowdown because we had double-digit negative sales comps, all of a sudden it would come storming back the next month. So I think that any short period of sales comps, I would be very suspect to use that as a basis for a downturn.

However, the kinds of things that you look for is your sales activity, but I think you have to take it over a longer period of time in order to really see if it's sustainable, and longer -- I don't know what that means but, you know, you can follow backlog. You know, the big builders today are running big backlogs and, you know, we're running an approximate -- what have we got, five-month ...

Over five.

... over five-month backlog. When you start seeing the backlog numbers go down, I think that is a warning sign.

... 42 percent cancellation rate, is that in the first couple of weeks?

Well, I thought the number we just gave was 39.

Oh, OK. So 42 was last quarter.

Yeah, last year was 42.

Yeah.

OK. Is that consistent with what's going on?

No, but is that typically in the first couple of weeks of - from the order being received, or could it be that your backlog could ...

Yes, the answer is yes -- yes. The can rate primarily develops very early on in the sales process, because buyers do not qualify for a loan.

Do you have that rate by region, by any chance?

I'm sure we do, but again, why don't you call back.

I'll follow up. OK. Thanks.

And our next question comes from Mike Shrekgast from Delaware Investments.

My question was answered. Thank you.

We'll take our next question from Rick Kwas of Banc of America Securities.

Hi, Bruce. I just wanted to check in -- you guys had a great year in terms of gross margins, and obviously that's been fueled by ASP growth, but I wanted to check in and see how the progress of the national purchasing program is coming, and what kind of cost structure savings are you seeing from that?

The national purchasing program, which has now been part of our organization for six or seven years, is continuing to evolve very positively. We received in hand approximately $30 million of rebates this past year, and we expect the number to significantly increase in '03.

I guess, let me sort of make general comments about it. One, as we continue to get bigger, the playing field gets leveler with manufacturers, and a number of manufacturers have figured out, that if they don't enter into a national contract, that they may just totally be unable to get in and sell us at any point in the future. So there's a lot more interest from contract -- from manufacturers.

Secondly, we are finding many more items that we can contract either on a national or regional basis that can save us a considerable amount of money, and a big part of an effective national contracts program is to get all of your operating businesses to agree to use the same products in their homes. And that is something that we have been successful with, all of our operating leaders understand it, and so they put aside personal preferences in the interest of doing something for the company as a whole. So that is an area that we believe will continue to be a fruitful area of revenue growth going forward.

And then, just best guess, in terms of just cost savings, I mean, how much do you think that it's really impacting margins? Is it split between, you know, being able to grow ASP and just strong demand function evenly with, say, cost savings or, you know, is it weighted towards any particular side in terms of, you know, just margin growth?

Rick, it really depends on the market. In our business model, we constantly focus on ways to do it, faster, better, cheaper. And a lot of our margin improvement is due to cost savings. It's also due to our focus in studio results, which were up for the year. We have a heavy focus on lot premiums, which is up for the year. And then, in some markets like California, we've been able to improve margins with some opportunities in pricing.

So it's a little of everything. I don't know that we have it broken down per component.

Great. Thanks so much.

I think we're going to have to maybe cut it off after another question, because we got sort of a busy schedule here this morning.

OK. Our last question comes from Steve Fockens of Lehman Brothers.

Hi, guys. A quick question -- if you could comment at all on California -- or the state of California recently, in terms of recent water rights issues that we've seen in the press, or large budget shortfalls. Are either of these items that concern you in any way about the home building business over the next 12 to 24 months?

No. No. Those are big-time -- they're issues. To give you an idea, we've delved quite deeply into the effect on the budget cutbacks due to the deficit on employment in Sacramento, which one might think would be adversely effected. In fact, most of -- almost all of the personnel cutbacks in the state are not going to happen in Sacramento. So that's one.

Water, big issue, long-term issue. Very long-term issue. Nothing that is going to affect future development for four, five, six years. And there are solutions. You know, there's prices that need to be evaluated, but there are solutions. So we track it, we have opinions about many of the things, some we don't. But it's nothing that we think will affect the building business in the state for the next number of years.

I'm sorry. And then, on the budget side, if Governor Davis tries to increase taxes or anything like -- well, being on the other coast, I have no idea whether that will go through or not. But would any of that kind of thing -- issue - or impact the ability of ability to buy homes, or is that, on a per-family basis, too small to really worry about?

I think it is. You know, he's already outlined what he is recommending, which is essentially, you know, a significant increase in the cigarette tax, the sales tax, one percent increase in the sales tax, and then, on the top end, unfortunately, an increase in state income tax for top-end taxpayers, which will not affect our home buyers.

Great. Thank you very much for your comments.

Good. Now, let me just, one, thank you very much for your participation. Let me reiterate that we -- our business is really in a solid state, and we have a great deal of optimism for 2003, and that hope to see many of you -- we are have ago breakfast meeting in New York on February 10th, and we're having a luncheon meeting in Boston the next day on February 11th, so if you'd like to receive any information on the luncheons, please contact Clem, Director of Investor Relations, and look forward to seeing you next quarter -- talking to you next quarter. Have a great day.

That concludes today's conference. We thank you for your participation.